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New Accounting Rules Add Clarity, Flexibility to FX Hedging and Reporting

By Megan Doyle

New accounting rules issued in August 2017 by the U.S. Financial Accounting Standards Board (FASB) aim to make companies' reporting on hedging activities — including foreign exchange hedging — better reflect the full range of their risk-management activities, while simultaneously becoming easier to interpret and understand.

The new hedging standards for foreign exchange and other hedges will become effective for fiscal years beginning after December 15, 2018 for public companies and a year later for private companies, with application for early adoption available. Organizations using FX hedging should expect to incur some costs while transitioning to the new accounting rules, but the FASB expects ongoing costs of the new standards to be lower than those incurred from the current requirements of Generally Accepted Accounting Principles (GAAP).1

 

The standards will "better align accounting rules with a company's risk management activities, better reflect the economic results of hedging in the financial statements, and simplify hedge accounting treatment," according to FASB Chairman Russell Golden.2 The FASB surveyed financial regulators and preparers through a variety of methods to identify key practice concerns as a basis for developing the new standards.3

 

More Flexibility, Simpler Disclosure, Lower Administration for Foreign Exchange and Other Hedges

 

Established as amendments to GAAP, the rules encompass three areas for foreign exchange traders and companies using other forms of hedging: increased flexibility of hedging practices, simpler presentation and disclosure of those practices, and simplifying administration.4 The amendments grant more flexibility for FX hedging of variable and fixed-rate financial instruments. The FASB is eliminating the concept of "benchmark interest rates" in favor of making "any contractually specified rate" eligible for hedging.5 For fixed-rate financial instruments, the Securities Industry and Financial Markets Association (SIFMA) swap rate is now eligible to be designated in interest rate risk hedging.6

 

Key to companies doing international business, the amendments expand hedge accounting to include nonfinancial hedges like commodities. This allows companies to broaden their risk management activities to include FX hedging of internationally traded commodities.7 In other words, companies can designate as a hedged risk the variability in cash flow associated with changes in a contractually specified part of a contract.8 For example, a U.S. steel company importing iron ore from Australia could single out its foreign-exchange-related iron ore price risk for hedging purposes; that would help prevent major earnings swings that otherwise might be inaccurately interpreted when reported on quarterly income statements. Being able to manage the risks of foreign exchange on commodities in international business gives companies more adaptability to use accounting models that accurately reflect risk management strategies.9

 

The new standards for presentation of risk management results on income statements aims to promote transparency, comparability, and improve clarity. For example, they require the earnings effect of hedges, including FX hedges, to be shown in the same line item as the value of the hedging instrument. Disclosure tables must show the effect hedge accounting has on individual income statement line items. Further, they stipulate disclosure of basis adjustments to fair-value hedges of interest rate risk. Finally, to reduce confusion, the FASB eliminated separate measurement and reporting of hedge ineffectiveness.10 In other words, there will not be a separate measurement indicating "ineffectiveness," even if a derivative was, overall, highly effective.11

 

Assessing hedge effectiveness, measured by the extent that changes in cash flows of the hedging instrument offset changes in the cash flows of the hedged item, is a key requirement to using FX risk management strategies.12 But it is often complicated and time consuming. The standards update provides SMEs, private institutions, and non-profit organizations with more leniency when measuring hedge effectiveness. Ability to use qualitative assessments, which allow an entity to make an assumption that their hedge will be highly effective, should help reduce cost and complexity of the process. In addition, more time will be granted when using quantitative methods, also known as "long-haul" methods, making it easier for entities to provide quantitative analysis to demonstrate their hedge will be highly effective.13

 

By offering greater simplicity, more variable options, and more time to meet documentation requirements, the FASB hopes to ease the administrative burden around hedging financial risks when doing business, whether internationally or domestically.14

 

The

Takeaway:

The FASB has issued new rules that aim to increase the flexibility of international businesses' foreign exchange hedging activities, while reducing cost and complexity of reporting on those activities. The new rules will come into force beginning at the end of 2018.

Megan Doyle - The Author

The Author

Megan Doyle

Megan Doyle is a business technology writer and researcher based in Wantagh, NY, whose work focuses primarily on financial services technology.

Sources

1. FASB Understanding Costs and Benefits, FASB; http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176169276313
2. “New FASB standard aims to simplify hedge accounting,” Journal of Accountancy; https://www.journalofaccountancy.com/news/2017/aug/new-fasb-standard-hedge-accounting-201717342.html
3. “Need to Know: The Upcoming Hedging Standard,” FASB; http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176169221956
4. Ibid.
5. Financial Accounting Series: Derivatives and Hedging (Topic 815), FASB Accounting Standards Update; https://asc.fasb.org/imageRoot/38/112270638.pdf
6. “Need to Know: The Upcoming Hedging Standard,” FASB; http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176169221956
7. Accounting Standards Update No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, FASB In Focus; http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176169276342
8. Financial Accounting Series: Derivatives and Hedging (Topic 815), FASB Accounting Standards Update; https://asc.fasb.org/imageRoot/38/112270638.pdf
9. “FASB Proposal Looks to Trim ‘Hedge Accounting’ Requirements,” The Wall Street Journal; https://www.wsj.com/articles/fasb-proposal-looks-to-trim-hedge-accounting-requirements-1490619600
10. “Need to Know: The Upcoming Hedging Standard,” FASB; http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176169221956
11. “New FASB standard aims to simplify hedge accounting,” Journal of Accountancy; https://www.journalofaccountancy.com/news/2017/aug/new-fasb-standard-hedge-accounting-201717342.html
12. Basics of Hedge Effectiveness Testing and Measurement, FiNCAD; https://www.cmegroup.com/education/files/basics-of-hedge-effectiveness.pdf
13. Accounting Standards Update No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, FASB In Focus; http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176169276342
14. “FASB Proposal Looks to Trim ‘Hedge Accounting’ Requirements,” The Wall Street Journal; https://www.wsj.com/articles/fasb-proposal-looks-to-trim-hedge-accounting-requirements-1490619600

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